Emerging-Market Issuers Vulnerable on $2 Trillion Debt Binge

June 30 (Bloomberg) -- Emerging-market companies that took
on more than $2 trillion of foreign borrowing since 2008 are
vulnerable to an evaporation of funding at the first sign of
trouble, according to the Bank for International Settlements.

Bond investors willing to lend generously when conditions
are good can pull out in a crisis or when central banks tighten
monetary policy, analysts led by Claudio Borio, head of the
monetary and economic department, wrote in the BIS annual
report. Emerging-market companies that lose access to external
debt markets may then be forced to withdraw bank deposits,
depriving domestic lenders of funding as well, they said.

Low interest rates and central bank stimulus in developed
nations, combined with a retreat in global bank lending, have
encouraged emerging-market borrowers to raise debt abroad,
according to the Basel, Switzerland-based BIS, which hosts the
Basel Committee on Banking Supervision that sets global capital
standards. Demand for higher-yielding securities also helped
suppress borrowing costs for riskier issuers.

“Like an elephant in a paddling pool, the huge size
disparity between global investor portfolios and recipient
markets can amplify distortions,” the analysts wrote. “It is
far from reassuring that these flows have swelled on the back of
an aggressive search for yield: strongly pro-cyclical, they
surge and reverse as conditions and sentiment change.”

Average nominal yields on long-term bonds of emerging
nations fell to about 5 percent as of May 2013, from 8 percent
at the beginning of 2005, according to the BIS. Adjusted for
inflation, this amounted to real long-term rates of just 1
percent last year, it said.

‘Excessive Leverage’

Loose financing conditions “feed into the real economy,
leading to excessive leverage in some sectors and overinvestment
in the industries particularly in vogue, such as real estate,”
according to the report. “If a shock hits the economy,
overextended households or firms often find themselves unable to
service their debt.”

Emerging-market companies sell bonds mainly through foreign
units, exposing them to currency risk, the BIS said. The true
size of their borrowing could also be masked as foreign direct
investment, making it a “hidden vulnerability,” according to
the report.

With emerging markets becoming more important to the global
economy and financial system, any stress affecting them will
probably hurt developed nations, too, it said.

Market Selloff

“The ramifications would be particularly serious if China,
home to an outsize financial boom, were to falter,” the
analysts wrote. That would hurt commodity exporters that have
seen strong credit and asset price increases drive up debt and
property prices, as well as other nations still recovering from
the financial crisis, the BIS said.

Emerging markets were roiled in May 2013 after former
Federal Reserve Chairman Ben S. Bernanke signaled the U.S.
central bank may considering withdrawing stimulus. While a
contraction in Chinese manufacturing helped spark another
selloff in January, bond prices soon recovered, evidence of “a
puzzling disconnect between the markets’ buoyancy and underlying
economic conditions globally,” the BIS said.

Emerging nations now look more resilient than they did a
year ago, according to Barclays Plc analysts Christian Keller
and Koon Chow writing in the London-based bank’s Emerging
Markets Quarterly.

‘Unsuspected Vulnerabilities’

Weaker currencies and higher interest rates help make
policy adjustment easier and support investor appetite for
emerging-market assets, they wrote. A revival of global growth
should help backstop emerging economies, according to Barclays.

Countries have also reduced their vulnerability by cutting
current-account deficits, a process that’s expected to continue,
the Barclays analysts said.

Although emerging markets have sought to make themselves
more resilient by running current account surpluses, boosting
foreign exchange reserves, making exchange rates more flexible
and strengthening financial systems, those measures may be less
effective than hoped, according to the BIS.

“Historically, some of the most damaging financial booms
have occurred in countries with strong external positions,” the
report said, citing the U.S. ahead of the Great Depression and
Japan in the 1980s. “Time and again, in both advanced and
emerging market economies, seemingly strong bank balance sheets
have turned out to mask unsuspected vulnerabilities that surface
only after the financial boom has given way to bust.”